SLATS: A Spousal Shelter With Benefits

By Richard C. Morais

This article was written by Tatiana Serafin.

No secret that absent a change in the law, the gift tax exemption is set to expire at the end of the year, eliminating the opportunity to shelter a full $5 million (or $10 million for a couple) from the expected rise in estate taxes. One way to have your cake and eat it too is to create a “spousal limited access trust,” also known as a SLAT.

The concept of the trust is simple; it’s a set-up for the benefit of your spouse, with the remainder of the assets passing tax-free to the family at your spouse’s death. The fun part is that it also allows you, rather sneakily, to indirectly benefit from the set-aside funds while you are both alive. “It’s a hedge-your-bets kind of trust,” says Jennifer Immel, Senior Vice President, PNC Wealth Management.

Dan Picasso for Barron’s

Here’s how: You make a gift of cash or assets to an irrevocable trust (for it to be counted as a gift, the gift must be irrevocable), and then for the lifetime of your spouse, the trustee distributes income and principal to your spouse, which of course can benefit you as well. The gift also removes these assets from your estates for estate tax purposes.

Mary Ann Sisco, Director of PFS Client Solutions at Northern Trust, recently counseled a client who had a great deal of real estate and was married with two children, a son and daughter. The father wanted to gift real estate assets to his unmarried daughter, but he worried about changing economic circumstances and needing extra money. He also did not want to make the same gift to his son because the young fellow had married without a prenup.

In the end, the father and his wife decided to set up two SLATs, putting about $4 million in each. He and his children were the beneficiary of one of the trusts set up by his wife with assets she owned in her name, with both children to receive the lucre after his death. His wife and daughter were the current beneficiaries on the other SLAT, with each receiving equal distributions. This second trust gave him a way to see how his daughter would handle her eventual inheritance. He hopes to make distributions to his son in the future.

If this all sounds too sweet to be true, be forewarned that there are some potential pitfalls in SLATs. To make a SLAT stick, and prevent the IRS from questioning the gift, you have to make it airtight. That means, since it is created during your lifetime, the trust needs to be carefully drafted to prevent those gifted assets from being brought back into your taxable estate after your death, which would create an unexpected tax slam for your heirs. It must be clear that you no longer have control over the trust assets and that you will receive no direct benefit from the trust.

It is also important to look at how your SLAT is funded. The assets put in the trust should belong to you alone – they should not be jointly owned with your spouse. That way you are gifting your property to your spouse, your spouse will have no retained right in the property, and you may avoid an IRS challenge to bring the trust’s assets back into your estate after you die.

Avoid signs of collusion. If both you and your spouse create SLATs for each other to get the full benefit of the $10 million gift tax exemption, be careful that each trust is written differently. “It should not be an agreement you had to give each other money,” says Northern Trust’s Sisco. The trusts should be different in meaningful ways; from different trustees, to different funding vehicles, to different remainder beneficiaries and different set up dates, advises N. Todd Angkatavanich, partner at Withers Bergman.

With the gift tax exemption expiring this year, there is a slight chance these assets could be “clawed backed” into the calculation of your federal estate tax. What that means is, if you give away $5 million this year and then pass away next year when the exemption goes back to $1 million, the IRS may tell your spouse she owes additional taxes on the $4 million. Another unresolved and ongoing IRS issue is how to value the assets in trust, especially shares of closely held companies. In certain cases –especially when there is significant short-term appreciation of the asset –the IRS can challenge the value of what you transferred. “For example, if you transfer real estate worth $100,000 to the trust, and the trust sells the property soon after for $300,000, the IRS may challenge your original valuation,” says PNC’s Immel.

Even with the IRS issues clarified, there are two additional problems – divorce and death. Both can adversely impact SLAT distributions – and give you heartburn. “The reality is that family relationships change, but the gift trust is irrevocable,” says Northern Trust’s Sisco.

In a divorce, your spouse can walk away with the trust and all distributions. A philosophical outlook will help soften the blow: if you consider the trust marital property, you are in fact losing the assets you would have to forgo in a divorce in any event.

Some use clever weaseling techniques to get around the divorce threat. Consider them if you are into serial marriages. One way is to write provisions that your spouse can only get a limited amount of distributions from the trust, saving the bulk of the stash for the kids or remaining beneficiaries. Or write the spousal definition in the trust to benefit the person you are currently married to, as opposed to naming a specific person. The minute your current spouse ceases to be your spouse, they stop being a beneficiary of the trust by definition.

There is a final problem. In the case where one spouse dies before the other, benefits pass to the next generation. “What if the surviving spouse still needs access to the trust assets to maintain the survivor’s lifestyle?” asks PNC’s Immel. One option might be to give the spouse the ability, through the deceased’s will, to use any assets remaining in the trust for their own purposes. Or consider buying life insurance on each spouse to replace those assets the dead spouse left to the next generation.

But act now if SLATs got your heart going pitter-patter. The window is closing. As Sisco notes, the great attraction of this sort of trust is that people “can gift in a way that is comfortable for them.”

Add a Comment

We welcome thoughtful comments from readers. Please comply with our guidelines. Our blogs do not require the use of your real name.

Comment

There is 1 comment

SEPTEMBER 20, 2012 9:13 P.M.

Tony Cecil wrote:

Most of these trusts really end up meaningless, as the assets ---which are valuable today--can loose value tomorrow, and in the case of property--the property taxes and insurance have a tendency to de-value over time....The best thing a person can do is just give what they can, while they are alive, and if the next generation mis spends---so be it--- You still love them anyway Tony

To report offensive comments email

About Penta

Written with Barron’s wit and often contrarian perspective, Penta provides the affluent with advice on how to navigate the world of wealth management, how to make savvy acquisitions ranging from vintage watches to second homes, and how to smartly manage family dynamics.

Richard C. Morais, Penta’s editor, was Forbes magazine’s longest serving foreign correspondent, has won multiple Business Journalist Of The Year Awards, and is the author of two novels: The Hundred-Foot Journey and Buddhaland, Brooklyn. Robert Milburn is Penta’s reporter, both online and for the quarterly magazine. He reviews everything from family office regulations to obscure jazz recordings.